CD Ladders – My Take

A few weeks ago a friend wrote an article about his experience with his CD Ladder. That article led to a comment, a follow-up article, and a promise from me to craft an article sharing my opinion and perspective on the topic. Today, I (finally) make good on that commitment.

So you ask, what the heck is a CD Ladder? Great question. It was not that long ago that I asked the very same question. To be fair, I have seen multiple interpretations and applications. But this being my muse, I’ll start by dispensing my interpretation.

I generally define a CD Ladder as follows:

A series of CDs with tiered or layered or graduated maturity dates often established to safeguard emergency funds or savings while distributing interest rate risk across the portfolio.

Nice… but what does that mean?

Ok, you know that CDs come in different maturities and each maturity will offer a different rate of return. For example, the return on a 5 year CD purchased today will differ from that of a 6 month CD purchased today. If you wait 3 months to make those same purchases you will likely find that both of these available rates have changed. Therefore, if I purchase a single year CD using my entire bankroll I’ll earn a single rate of return for the duration – good or bad – and the same goes when it renews. However, if I use 25% of my bankroll each quarter to purchase a series of 1 year CDs, I’m likely to experience 4 unique rates of return – again, good or bad – and again, the same goes as they renew.

The second example starts to resemble a ladder with each maturing CD a rung on the ladder. In this example, the rungs are 3 months apart, which helps provide increased liquidity over a single 12 month CD, in addition to the greater interest rate diversification.

Why Have One?

When I first started reading about CD Ladders I was convinced it was a much ado about nothing situation. I believe that the value of an Emergency Fund is in the inherent preparedness for an Emergency. Those funds are intended for defense rather than offense so be they in a money market account or your sock drawer their utility is sustained.

I’ve since come to appreciate that the maximized reality may be more nuanced. Sure, the stated objective of an Emergency Fund is as simple as that – cash at a time of need, and any gyrations perpendicular to that end should be avoided.

However, that does still leave room to operate and I’ll share 2 such movements that have swayed my response to CD Ladders.

1. Emergency Funds are only for emergencies and said funds should not be accessed for anything shy of a certified emergency.

We’ve all seen the fire extinguishers behind the glass with the placard “break glass in the event of an emergency”. Human nature being what it is, a fire extinguisher sitting on a table invites horseplay. The simple plate of glass requires vandalism to achieve the same horseplay. Clearly not worth the effort.

A stack of Benjamins functions in much the same way. Sitting in the bottom of my sock drawer I can hear them beckoning for my attentions even now. In my moment of weakness no one will know but me. However, preserved in the confines of a CD, I have to take public action… and human nature being what it is, those actions start to sound like work… and so my money remains safe from my own hand.

2. Have an “every little bit matters” mentality.

Imagine if I eat one less Oreo everyday but keep my activity level the same. I’ve just made a difference. Small, yes, but still a difference. Add in other small changes and my waistline starts to register an impact. The same principle applies to our finances as well. By actively seeking a solution that adds 1 or 2 or 3 percentage points to my bottom line, I can train myself to look for similar opportunities elsewhere and collectively my balance sheet starts to register an impact.

What’s the Downside?

Is there a downside to building a CD ladder? Our world is round and it spins so things move and little is truly perfect. But the downsides of the Ladder are minimal given appropriate efforts.

1. The first of 2 downsides is the time required to build a proper system. Borrowing from our previous example, the quarterly ladder would require 9 months to properly affect – January 1, April 1, June 1, and October 1 – assuming it is stocked with 12 month maturities.

My thoughtful counter to this complaint is… “whaaa”. Look folks, neither Rome nor your financial security are built in a day, so invest some effort if you aspire to such a fiscal security system.

2. The second downside is a function of the perfected creation. Once built, I don’t want to break it, so I’m actually encouraged to use credit when an emergency strikes.

My reaction here is not dissimilar. If you are willing to overlook available cash to satisfy an emergency with credit, then perhaps you need to reevaluate your definition of an emergency.

Perhaps these are aggressive stances – relative to these downsides – but they are authentically mine and hopefully they will inspire thoughtful consideration if your first response was not one of agreement.

How do I perfect My CD Ladder?

So clearly I am a fan of building a CD Ladder, but how have I designed my own Ladder?

To be clear, I have not yet built my CD Ladder but I have certainly designed it. Using fictitious numbers, here is my design plan from the ground up:

Desired Emergency duration/coverage – 12 months

Monthly budget obligation – $1,000

Total Emergency Fund requirement – $12,000

Rung Size, or time between maturities – 1 month

To execute the build, I’ll need to purchase a $1k CD early each month for a full year – 12 such purchases. However, the beauty is that each maturing CD will fuel that month’s household expenses – during a time of need. (Specifically the early month maturity is designed to help cover mortgage payments).

To address immediate issues – think a sudden illness rather than next month’s layoff – I’ll park another $1k in a savings account (or sock drawer) for “1 minute access”.

Granted, such an elaborate concoction will take time and some precision to construct, but imagine the nights of peaceful sleep it will engender once in place.

So there you have it. My take and blueprints related to CD Ladders. Material probably a year in the making when you consider the evolution of my perspective, and I trust you will find it worth the effort.

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